Hi to all,

I am working on NK-DSGE model with informal sector. My impulse responses are not coming back to the steady state and I am also not getting the theoretical moment of some of the varialbes. Could anyone help me how to solve this problem of unit room from the model. Looking forward for response.

Please find the attached code

Regard,

Tehseen Iqbal

informalsector2.mod (9.32 KB)

You are the model builder. So you are the only one who knows why there is a unit root. For the price levels, this is no surprise, because the New Keynesian model with an interest rate rule only determines relative prices and inflation rates uniquely, but not the price levels. But this does not explain the second set of unit roots that seem to affect real variables. According to model_diagnostics, the first Euler equation is involved. Are you sure that equation is correct?

Dear jpfeifer,

The problem of unit root doesn’t arise if I am simulating the model without informal sector. In the simple model the problem of unit root comes only after adding the price level. When I am extending my model to include informal sector this price level is used in consumption of formal and informal economy. I am beginner I don’t have much idea but I think use of the price level is creating the problem and because of this in case of most of the variables the model fails to generate theoretical moments.

I need your comments on this whether I am right or wrong in assessing the source of problem.

Please find attached code of model without informal sector.

Regard,

Tehseen Iqbal

formalsector.mod (7.23 KB)

Then it must come from the informal sector. The problem is not the appearance of the price level per se. The price level is well-known to have a unit root in most New Keynesian models. The problem is that in your model it introduces a unit root in *real* variables. My guess is that you have a problem in at least one equation where you incorrectly mix real and nominal concepts.